In post-M&A purchase price disputes, the valuation analyst is often called in to measure damages due to misrepresentations by the seller. These typically involve financial statements and projections, information about key customers, existing or impending litigation, regulatory compliance, and the like.
Typical mistake: According to Jeff Litvak (FTI Consulting), a common error valuation analysts make is that they approach an M&A damages assignment as a revaluation of the company. “Some valuation experts get confused and think that you need to revalue the business on an impaired basis,” says Litvak. “That is not the right approach. You need to value the misstatement.”
Damages due to seller misrepresentations are measured on a “benefit of the bargain” basis. This is the difference between what the buyer bargained for and what was actually received due to the misrepresentation. If a misrepresentation results in a one-time, nonrecurring charge that does not impact future earnings, the value of the damage is measured on a dollar-for-dollar basis. On the other hand, if the misrepresentation does impact future earnings, the damage is measured “at the multiple,” based on the decrease in value due to the misrepresentation.
For example, assume Target Co. does not disclose a contingent liability relating to some environmental damage and Buyer Co. ends up having to pay a one-time $10 million cleanup charge because of it. Since there is no impact on future earnings, the damage is valued at $10 million. However, if Target does not disclose that it knows that a major customer will jump to a competitor, the damage is calculated based on the impact to earnings. For instance, if Buyer paid a multiple of five times EBITDA and the lost customer contributed $5 million to EBITDA, Buyer could claim that the value of the damage is $25 million ($5 million of lost EBITDA times the multiple of five).
Good case: In the upcoming April issue of Business Valuation Update, Litvak discusses a very good case in which he testified in the Delaware Court of Chancery. The case was settled before the court could render a verdict, but Litvak gives us an inside look at how it did the valuation of the M&A damage claim.
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